The Multilateral Tax Convention has been ratified
Pepeliaev Group advises that the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (“MLI”) has been ratified[1].
The MLI was developed by the Organisation for Economic Co-operation and Development (OECD). The MLI aims to prevent abuses of international double tax treaties (DTTs) when profit is artificially moved between states so that, in each such state, it is in part or in whole exempt from tax (so-called treaty shopping).
The MLI does not offer a unified approach to replace all the provisions of the existing DTTs. Bilateral DTTs continue to be in force and will be entered into in future. The MLI amends or clarifies only a limited number of provisions of existing DTTs. The text of the MLI contains options for the legal solution of individual issues of cross-border taxation to be implemented taking into account the reservations that states may introduce when ratifying the MLI.
Russia has extended the MLI to 71 DTTs, including treaties with states that are often used for international tax planning (such as Cyprus, Luxembourg, the Netherlands, Ireland and Hong Kong). The MLI still does not cover treaties with a number of other states which are important trade partners of Russia (such as Germany, Switzerland, Sweden and Japan) as well as a few other countries.
Russia has selected the following two tools to restrict benefits as provided for by the MLI:
The principal purpose test allows national tax authorities to refuse the application of benefits under a DTT if such application was the principal or one of the principal purposes of the structuring of transactions.
The simplified limitation of benefits is a formal set of requirements for the person claiming benefits under a DTT: such benefits should be granted to so-called ‘qualifying persons’, which include:
The definition of ‘preparatory and other auxiliary activities’ is being narrowed. The so-called anti-fragmentation approach is being introduced. This provides for a permanent establishment to be formed even where a single business process is structured in the form of individual transactions each of which has a preparatory or supporting nature and, taken separately, does not lead to a permanent establishment being formed. If the tax authorities identify such abuse in the taxpayer’s actions, each of the business units will be recognised as a permanent establishment for tax purposes.
As far as taxes paid in accordance with other procedures are concerned, these will be subject to provisions of the MLI after six months from their entry into force (taking into account three months after ratification, as mentioned above), but no earlier than 1 January of the following calendar year. For Russia, this is no earlier than 1 January 2021.
The MLI does not offer a unified approach to replace all the provisions of the existing DTTs. Bilateral DTTs continue to be in force and will be entered into in future. The MLI amends or clarifies only a limited number of provisions of existing DTTs. The text of the MLI contains options for the legal solution of individual issues of cross-border taxation to be implemented taking into account the reservations that states may introduce when ratifying the MLI.
 | The MLI model selected by the OECD as an ‘add-on’ for DTTs for certain situations not only simplifies the existing approaches but also increases the variety of rules that may be implemented. |
Russia has extended the MLI to 71 DTTs, including treaties with states that are often used for international tax planning (such as Cyprus, Luxembourg, the Netherlands, Ireland and Hong Kong). The MLI still does not cover treaties with a number of other states which are important trade partners of Russia (such as Germany, Switzerland, Sweden and Japan) as well as a few other countries.
| In order to assess whether the rules for taxing international transactions with a specific country are changing, it is necessary to assess whether the MLI has come into effect for such country and what reservations were introduced in relation to that country’s treaty with Russia when the MLI was ratified. For example, the USA is still refraining from even signing the MLI. |
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The OECD offers supporting materials for the MLI available at www.oecd.org/tax/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-beps.htm (the short reference is oe.cd/mli), including a matrix to check the status of the MLI and individual provisions of it (https://www.oecd.org/tax/treaties/mli-database-matrix-options-and-reservations.htm).
A correspondence table of conditions broken down by countries is available here: https://www.oecd.org/tax/treaties/mli-matching-database.htm. The OECD recommends that countries publish anew the existing DTTs to include amendments made further to the MLI, and proposes guidelines to this end. |
Restrictions of benefits
For the MLI, the provisions concerning the restriction of benefits that are set out in the DTTs are of key importance, for instance: the exemption from withholding tax and implementation of reduced tax rates in relation to taxable payments (e.g. dividends, interest, and royalties).
Russia has selected the following two tools to restrict benefits as provided for by the MLI:
- the principal purpose test (PPT); and
- the simplified limitation of benefits (S-LOB): the beneficiary of the income is required to meet stringent and formal criteria; however, a competent authority may also grant tax benefits to other persons claiming them only if it is proved that the principal purpose of such persons, who do not meet the formal criteria, is not to obtain benefits under a DTT.
Most countries have selected the principal purpose test for treaties with Russia. The simplified limitation of benefits tool will not be implemented with these countries.
The principal purpose test allows national tax authorities to refuse the application of benefits under a DTT if such application was the principal or one of the principal purposes of the structuring of transactions.
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The requirement that there must be a business purpose not associated with tax is not new for Russian tax law since it is enshrined in article 54.1 of the Russian Tax Code and had been implemented in court practice even earlier. However, whereas article 54.1(2)(1) of the Tax Code requires that tax saving should not constitute, specifically, the principal purpose, the principal purpose test presents, within the framework of the MLI, the requirement is set out with an even stricter wording: if tax saving was only one of the principal purposes, the benefit will be refused. On the other hand, Russian tax authorities, with courts close behind, can currently refuse to recognise such purposes which do not explicitly prevail in comparison with the tax savings that the parties obtain.
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The simplified limitation of benefits is a formal set of requirements for the person claiming benefits under a DTT: such benefits should be granted to so-called ‘qualifying persons’, which include:
- individuals;
- subjects of public authority;
- companies (other persons) owning shares the main class of which is traded on recognised stock markets on a regular basis;
- not-for-profit organisations the types of which have been agreed by the parties to the relevant DTT;
- pension and other social funds, as well as entities investing the monies of such funds; and
- other persons that are not individuals if, during at least half of the days within a twelve-month period, the above persons have directly or indirectly owned no less than 50% of the shares of the recipient of the income.
A number of other conditions require a body of evidence to be submitted and assessed, which makes it more difficult to confirm that these conditions have been met:
- the recipient of the income pursues active entrepreneurial activities in the country of its residence, and the income received in the source country is generated or connected with such activities (holding, management and financing companies are directly excluded from this category);
- the entrepreneurial activities that the recipient of the income is pursuing in its country are more substantial than the activities that such person is pursuing in the source country by itself or through its related person paying the income;
- during half of the days of any twelve-month period, equivalent beneficiaries, i.e. persons having the right to similar or more advantageous benefits on any grounds, directly or indirectly own at least a 75% membership interest in the resident claiming preferences under the relevant DTT.
If a resident is not a ‘qualifying person’ and has no right to benefits on the other grounds set out above, the competent authority of the contracting state may grant preferences under the relevant DTT if such resident proves that neither its formation (acquisition or holding in a group of companies) nor its performance of transactions entailed, among their principal purposes, the purpose of obtaining preferences under the DTT.
However, the simplified limitation of benefits tool is implemented only on condition that both parties to the relevant DTT have provided for it to be implemented. Countries which are often used in cross-border transactions with Russian businesses, such as Cyprus, Luxembourg and the Netherlands, have selected only the principal purpose test and will not implement the simplified limitation of benefits in global transactions with Russia.
For the purpose of applying reduced tax rates in relation to dividends, the MLI introduces the requirement of uninterrupted membership in an entity for 365 calendar days. This rule adds to, but does not supersede, the conditions effective in the DTT.
Indirect sale of real estate
Indirect sale of real estate
Where real estate is sold indirectly through the sale of shares and similar rights (membership interests) and no less than 50% of the value of such shares or rights consists of real estate, tax is assessed in the country where the real estate is located (including Russia) if the above ratio has been exceeded during any period within the 365 calendar days preceding the transaction in question.
Permanent establishment
The MLI introduces significant changes in the taxation of a permanent establishment.The definition of ‘preparatory and other auxiliary activities’ is being narrowed. The so-called anti-fragmentation approach is being introduced. This provides for a permanent establishment to be formed even where a single business process is structured in the form of individual transactions each of which has a preparatory or supporting nature and, taken separately, does not lead to a permanent establishment being formed. If the tax authorities identify such abuse in the taxpayer’s actions, each of the business units will be recognised as a permanent establishment for tax purposes.
The MLI introduces rules which prevent contracts on a construction site from being artificially severed in time to avoid a permanent establishment. Russia has introduced the reservation that these regulations will not be applicable to it with regard to the terms and conditions of certain Russian DTTs associated with the exploration and production of natural resources (for instance, the DTTs with Norway and the Netherlands).
A permanent establishment is now formed via a dependent agent when such agent not only systematically enters into contracts on behalf of the enterprise but also plays the principal role in entering into them.
The country which is the source of the income may tax the income that a permanent establishment pays to a person located in a third country, if such income in the third country is subject to reduced taxation, whereas in the country of residence of the company of which a permanent establishment arises, such income is entirely exempt from tax. The MLI sets out exceptions for income received in connection with the active business operations pursued by such permanent establishment.
Persons with double tax residency
Persons with double tax residency
In order to identify the tax obligations of persons with double tax residency, Russia will apply mutual agreement procedures instead of the ‘place of effective management’ test (although the latter is stipulated by article 246.2 of the Russian Tax Code). Should it be impossible to reach an agreement between the competent authorities of the contracting states, no preferences under the relevant DTT will be granted to the taxpayer. However, the competent authorities of the contracting states have the right to make an agreed decision as to the extent of the preferences that still can be granted.
However, this stringent approach will not be implemented in relation to a number of DTTs (for instance, those with Cyprus, Luxembourg, Malta and Singapore).
Mutual agreement procedures
If a dispute arises regarding the implementation of most of the DTTs entered into by Russia, the taxpayer has the right, within three years after becoming aware of the actions that caused taxation to be implemented other than in accordance with the relevant DTT, to address a competent authority of the contracting state to conduct a mutual agreement procedure.
| Russia has made the reservation that arbitration proceedings are not applicable as another form of dispute resolution. Therefore, all disputes between Russian and foreign authorities may be resolved only within the mutual agreement procedure. Previously, we have already written in detail about the regulations concerning the mutual agreement procedure drafted by the Russian Ministry of Finance[2]. |
MLI provisions coming into force
The MLI will come into force for Russia starting on the first day after three calendar months have expired from the date when Russia deposed the ratification document for keeping.
The MLI provides for various periods to start implementing the regulations in relation to
- withholding tax;
- taxes paid in accordance with other procedures; and
- mutual agreement procedures.
The MLI is applied to withholding tax starting from 1 January of the year following the year when the MLI entered into force for each of the countries which are parties to a relevant DTT. Accordingly, the MLI will apply starting from 1 January 2020 to Russian treaties with countries which have already ratified the MLI, as well as to countries which manage to ratify and submit the relevant documents to the OECD before 1 October 2019.
As far as taxes paid in accordance with other procedures are concerned, these will be subject to provisions of the MLI after six months from their entry into force (taking into account three months after ratification, as mentioned above), but no earlier than 1 January of the following calendar year. For Russia, this is no earlier than 1 January 2021.
What to think about and what to do
We recommend analysing, in good time, how the MLI will affect your existing models of pursuing cross-border business and determine the necessary changes.
Help from your adviser
Pepeliaev Group’s lawyers will readily provide advice on the following aspects:
- assessing the changes in the taxation rules for international transactions within the framework of a DTT to which Russia has extended the effect of the MLI;
- the interpretation and implementation of the new MLI requirements;
- conducting a principal purpose test in accordance with the MLI's requirements;
- proactively drawing up a legal position and documentation allowing you to substantiate the application of preferential provisions of a DTT taking the MLI into account.
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[1] Federal Law No. 79-FZ dated 1 May 2019.
[2] https://www.pgplaw.ru/analytics-and-brochures/alerts/the-procedure-of-conducting-a-mutual-agreement-procedure-in-the-framework-of-agreements-on-avoidance/